Buffett's Wrong: Stay Out of Stocks

Smart money people like Warren Buffett are cherrypicking stock markets and the brilliant businessman from Omaha last week wrote that American investors should be doing the same.
Wrong and here's why:

The Omaha Oracle is wrong for you and me Warren Buffett's recent op-ed piece in the New York Times made a brilliant point, but was straight from the value-investor, long-term viewpoint: Buy bargains now when everyone flees and hang on for awhile. Far be it from me to contradict one of the world's greatest stock sages and business analysts. But I will. Seems to me that we are in uncharted territory with this panic until the U.S. election is staged on November 4 and until the global community demonstrates that it is going to appoint sheriffs to patrol the global economy and stop the kind of jurisdictional arbitrage that led to the casino-ization of banking.

The hedge hangover

The other issue ruining stock markets right now is that they cannot fulfil their function which is to properly determine fair price for equities and debt. The reason for this is another global governance failure: the proliferation of unregistered hedge funds in secrecy havens without any disclosure as to their ownership or activities.
Hedge fund investors are allowed to, once a year, give notice to their fund managers that they want out. The first deadline was Oct. 1 and the second Nov. 1. In other words, these investors have declared they want their money back by the end of the year giving either 90 days' notice or 60 days'.

The regulatory and investor problem is that there are US$2 trillion in hedge funds run out of the U.S. alone and nobody knows the percentage of redemptions they have been received. As one trader told me on Wall Street one month ago: "the hedge redemptions are enormous which means that these funds will be selling stocks to get cash to meet redemption requests into every stock market rally."

That means the markets will rally, be pushed down again to lower depths, rise to lower depths only to be pushed down, thus creating even more problems as margined accounts are sold into the lower values, mutual fund investors panick and on and on.

In this scenario, there is absolutely no such thing as a reliable pricing mechanism. There is absolutely no way in knowing which stocks are going to be dumped -- usually the best. And there is no way in determining whether this gigantic, global unwinding is a permanent revaluation lower of the world's wealth. In other words, there is absolutely no guarantee that multiples or share values will eventually return to their peak prices.
For me, buying and selling should not be an option at least until the U.S. election and probably until January 2009.

The day after the Nov. 4 election the world will learn whether this crisis will be commandeered by Team McCain or Team Obama. The differences will be startling in their approaches. Much will also depend on the Congressional races: Will the Democrats dominate with a heavy-handed approach or will populists from both sides of the aisle, upset with the bailout, dominate, thus resisting interventions?

Comments

[kapo]

The government is going to inflate its way out of this crisis. You are gonna be safer in stocks. A year ago, many people thought the prosperity was permanent. Now many believe a permanent depression looms. The problem for investors is not so much the immediate crisis as its solution. These guys are going for inflation. Also, if the redemptions are unquantifiable, how do you quantify them to reach your conclusion. You need to look at valuations going forward, look at the level the market has fallen from the peak, gauge whether the global economy is going to tank and then draw your conclusion. You are correct to focus on demand and supply, but that occurs within a context. In the long run you will make more money if you can keep the bigger picture in mind.

[emerywood]

You mean hedge fund and mutual fund investors cannot change their mind once they have placed a sell order ? I bet you if the market is rallying, a lot of them will cancel out their sell orders.

[Zeje]

No they won't.

[joebhed]

What took you so long, Diane?

[strangerinthenight]

A gallon of milk is more expensive that these junk stocks. The companies are too leveraged, assest are non-existent, deeply in debt and poor credit. No business can thrive under those cirmcumstances. Predictable failure. Their stocks are worthless.

It ain't rocket science.

[theeconomicfractalist]

Within the very short term - 15 or so equivalent trading days - longer for trading halts - an expected 40-80 per cent further nonlinear composite equity drop is expected: this author's opinion is not unreasonable.

[Sumocat]

If I followed Buffett's simple rule, "Be fearful when others are greedy, and be greedy when others are fearful," your fear-drenched opinion would drive me to buy up even more stocks.

[DuganS1]

Ya, but people were fearful when the S&P 500 was 10-20% higher. People were fearful when energy and basic material stocks were 35% off their highs instead of the 70-80% off many are today. The problem with "Buffet's simple rule" is that no one can accurately predict how low a market will go and for how long it will stay low.

[PDAGUY9]

Diane -

We are not in uncharted territories. As history shows us, everytime a panic sets in, prognosticators such as yourself claim we are in uncharted waters. But history proves you wrong every single time.

Now I don't doubt these are scary times, and for the average investor they may well want to avoid stocks (as most of us aren't afforded the luxury of Buffett's billions).

[cylindar]

I agree Buffett's advice is not the best to say the least. This is indeed uncharted territory.

[zizyphus]

I find it ironic that poor people, when they deposit a check in the bank, have to show ID to make that deposit. If I had a million bucks in black market proceeds, I can take it to my favorite hedge fund and invest it no questions asked.

I want to see the hedge funds and banks held accountable for all the money laundering and fraud that has been the party theme during the last administration. I am sick of all the politeness about not "pointing finger". Start some finger pointing and start at the top.

The "bailout" to the banks will be revealed by history as one of the final thefts of the Bush administration, where the most notorious liars in the world were awarded the whole pie. Are people in a trance? Wake up sleeping fellow Americans, you are being fleeced by pros. See you in the breadline, if there are any crumbs left.

[DuganS1]

What money laundering and fraud? How does the government injecting capital into banks by buying preferred shares equate to theft?

[gatzbp]

Actually Hedge Funds have Anti-Money Laundering (AML) laws and procedures that must be followed for any new money coming in. Most funds have an administrator on their funds (someone who deals with paperwork and incoming/outgoing money, etc) and the administrator also has legal liability to comply with AML (among other things).
I totally agree that 'not pointing the finger' is complete BS (and on the Bush theft administration) - in part this line I think is now used because if you have to point a finger, it lands squarely on the government... especially congress and the ratings agencies (moody's, S&P...). I'm not sure if we can post links here, but bloomberg had an excellent piece titled, "`Race to Bottom' at Moody's, S&P Secured Subprime's Boom, Bust ". Good comprehensive piece and definitely worth a read.
Anyway, hedge funds are far from being to blame here. E.g . look at David Einhorn of Greenlight Capital. He tried to say that Lehman was in trouble a long time ago and what happens? SEC tries to investigate him and Lehman threatens to sue him. If anything, hedge funds are the only folks that tried to loudly sound some warning bells back in 2007 into 2006.

[montemalone]

This bamboozle needs to be allowed to find it's own floor, without government subsidy.
For some reason, no one mentions that there were two sides to every trade. Money doesn't evaporate.
There is still plenty of money, it's just no longer controlled by the big banks, brokerages, and hedge funds.
Let "the market" balance itself.
There's absolutley no reason to artificially support those who gambled big.
Every game of Monopoly ends eventually. It's time to start a new one.

[DuganS1]

Money does evaporate. There may be two sides to every trade, but the price for the equity they come together at (the buy-sell price) determines the price of all the other shares of the equity owned. For example, investors own 3.7 billion shares of JP Morgan, but if 20 million shares trade down one morning by 20%, then all 3.7 billion shares outstanding are now worth 20% less.